What Does The Fixed Rate Represent on Strips?
When you trade an interest rate swap (IRS) on Strips, there are two rates being swapped.
Floating rate: the current funding rate at the referenced exchange. This rate is created independently of Strips and is a product of market action at the cited exchange (to learn more about perpetual funding rates and how to interpret them, read our explainer here.)
Fixed rate: the funding rate being traded on Strips. This is a product of market forces on Strips.
You may have noticed there’s sometimes a large delta between the floating and fixed rate:
If these two rates are nominally tracking the same thing, why the difference?
The floating rate is a point in time calculation that represents real-time market demand, directional bias, and perpetual price premium over spot. Similar to how spot commodity prices represent the demand for commodities now, and not their discounted value in the future, the floating rate is similar in this way.
However the fixed rate is a more nuanced figure, and has future expectations built into it.
When the market prices a bond or values a stock, what it’s fundamentally doing is discounting the value of the expected cash flows of that asset back to its present value, adding them up, and creating a price for that asset. How far ahead is it looking? For bonds: up to the expiration of the bond. For stocks: technically forever into the future, since stocks don’t have an expiration date.
There is a similar mental framework being applied to the expectations built into the fixed rate.
The fixed rate price on Strips reflects the market expectation of the compounded daily floating rate. What does this mean in practical terms though?
For example, picture daily floating rates for one week on FTX BTC perps: 3%, 2.5%, 3.1%, .3%, -.1%, -1%, .02%
Now imagine these rates projected out a week into the future. A month into the future. Years.
What you’re seeing encapsulated in the fixed rates on Strips is the collective market wisdom of what the compounded daily floating rate of the referenced perpetual will be extrapolated out to….. forever.
Technically “forever” since there is no expiration here. Practically though, you’re probably seeing embedded expectations for the floating rate perhaps a year or so out into the future. But this is speculation on exactly how far out the market is able to reasonably project.
There is wisdom in crowds and information embedded into simple numbers, and a powerful one is captured within the fixed rate on Strips. If you have any questions please join our discord.
Disclaimer
The information presented here is meant for educational purposes, and is not investment advice. Any past performance, projection, forecast or simulation of results does not necessarily indicate any investment’s future or likely performance. The information and publications are not intended to be and do not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort offered or endorsed by STRIPS Finance.
